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SEC unveils proposals to reform money-market funds

June 5, 2013

By Ronald D. Orol

WASHINGTON (MarketWatch) — In a long-awaited action, the Securities and Exchange
Commission on Wednesday proposed two reform alternatives for the money-market
fund industry, including one that would limit redemptions.

The first approach would abandon what’s known as a stable “net asset value” for the $1 trillion institutional prime money-market funds industry and require a floating NAV instead. Institutional prime funds, which invest in more than just government debt, account for roughly 37% of the money-fund industry.

If this approach is approved the value of these prime money-fund shares would no longer be fixed at the same price — $1 a share each — as they are today.

The agency sought to exempt retail investors by saying those who make redemptions of $1 million or more a day would be considered institutional investors and subject to the restriction.

Under the other approach, all prime money-market funds could be subject to a prohibition on investor redemptions or an imposition of fees for investors who seek to pull their capital out.

Specifically, if a money fund’s weekly liquid assets were to fall to below 15% of its total assets, the fund could need to impose a 2% liquidity fee on all redemptions. The fund could also temporarily suspend redemptions once their assets fall below that level.

However, that suspension is voluntary and a fund’s board could waive or lower the fee. Nevertheless, a fund manager would need to explain immediately in a public document why he or she didn’t impose the restrictions.

Thomas Gorman, a partner at Dorsey & Whitney in Washington, argues that the disclosure requirement would have the practical effect of forcing managers to impose the restrictions because it would be hard for them to explain why they are not doing it.

“This is a typical securities law approach that has the effect of getting what the SEC wants through disclosure,” Gorman said.

The SEC said it is considering whether to adopt just one of the two approaches, or both of them in a combination rule, a real possibility after four of the agency’s five commissioners appeared supportive of both tactics.

Troy Paredes, a Republican whose term is running out, was the lone clear opponent to a floating NAV approach, arguing that it suffers from “fundamental” issues.

“The bottom line under a floating NAV, when investors see signs of stress they will have an incentive to redeem sooner rather than later before the NAV floats downward. At a time of stress even investors that are accustomed to seeing a fund’s NAV fluctuate may redeem if they expect the fund’s price to fall.”

Elisse Walter, a Democrat commissioner whose term also is running out, indicated that the agency may be likely to adopt both rules. “As you heard several times already, these two options are not mutually exclusive solutions,” she said. “My preference would be to combine these two options.”

SEC Chairman Mary Jo White indicated that the floating NAV proposal was an “important” measure because it eliminates the ability of early redeemers to receive $1 a share even when the fund has experienced a loss and the shares are worth somewhat less than that.She added that by focusing on institutional investors, the proposal targets reform on the category of investors who drove the run on the markets during the 2008 crisis.

A research note issued by Bank of America Merrill Lynch reported that the immediate market impact of the proposal will likely be modest since there is uncertainty about the final result.

It noted that the most favorable impact would be to allow funds the option of choosing between the two approaches. However, the report added that the market is still ‘susceptible” to the impact of a stricter final rule that requires both provisions.

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